Seven Steps To A Successful Succession Plan

Maintaining your practice while planning for the future is critical to a profitable transition.


Published:

Amy Kauffman

One of the most important business decisions a practice owner can make is developing a succession plan. Just as it is vital to have a clear and thoughtful business plan with specific goals and objectives to develop a profitable practice, it is just as important to develop a strategy for that departure to run smoothly and profitably. A succession plan assures that one of your most valuable professional and financial assets will continue on successfully after your retirement and also provide you the maximum financial benefits.

The general economy has grown at a strong rate during the past 10 years. However, overall veterinary income has not. The income of individual veterinarians seriously lags behind that of similar professions. In addition, veterinarians now pay a considerably higher percentage of their monthly income to pay off educational debt than their dentist or physician counterparts (10 percent versus 8.6 percent for dentists and 5.3 percent for physicians)[1]. The average debt load per new graduate now exceeds $60,000 and continues to grow annually.[3]

The role of women within the profession has and will continue to change the veterinary economy. Women now make up nearly 70 percent of veterinary students and 36 percent of practicing veterinarians. The percentage of female veterinary practitioners will increase to 67 percent by 2015.[1]

As all practice owners (male and female) will eventually sell their practice, the above factors will affect future sales as practice ownership changes. These factors will continue to change and evolve as new information is published. Since higher incomes generally are associated with practice ownership, [2] sales and purchases will continue at an increasing rate during the first part of the 21St century. Due to the changing markets for practice sales, owners and buyers must plan ahead to achieve the greatest value. (See Table 1, Seven Step Succession Plan.)

The number of practices for sale will continue to increase during the next 15 to 20 years caused by the retirement of the baby boomers (they make up 40 percent of the work force). Baby boomers are generally people who are entering their 50s and were born between 1946 to 1964. Because of the steady state of the numbers of new graduates, and the increasing retirement of the boomers, more practices will become available. Since a major portion of veterinarians' retirement capital is tied up in their practices, maximizing the sale at the right time will be very important. However, some practitioners may be forced to continue to practice longer than they want if they have not planned ahead in order to find a qualified buyer(s).

Seven Planning Considerations

In order to maximize a practice sale, consider the following seven steps:

Step 1: Start planning for retirement at least seven to 10 years prior to retirement.

This sounds like a long time, but it is not when you consider it may take three to five years to find the right associate and another three to five years to phase-in the sale, and then another three years or so of part-time employment as you phase-out. Most veterinarians must work for five to 10 years to get everything organized for a successful sale and smooth transition for everyone concerned. Sometimes people get lucky and accomplish a sale in a year or two.

Step 2: Continue to aggressively grow the practice's gross and net income, especially during the last five to 10 years.

The value of the practice is a very important and challenging figure to develop. If the total practice value is divided into three components, the value can be obtained more objectively. The three portions of value are: 1. real estate, 2. equipment/supplies/drugs, and 3. client or goodwill value. Real estate values can be obtained from a commercial broker, while equipment/supplies/drugs can be self-evaluated. Good will, the most difficult portion of the practice value to establish, can be valued by a number of different methods from very sophisticated client record values to very simple percentages of gross income or net income. The most common method is to use a capitalization rate of 3.0 to 5.0 on the excess earnings, which is defined as the net income after all expenses have been paid except the owner's salary and profit. Regardless of the method used, the total value of the practice is only what the buyer is willing to pay. When the value becomes too high, then the buyer cannot make payments and still have enough to live on. The practice goodwill value can be established by hiring a management consultant or developing the value through self appraisal.

A good marketing plan that meets clients' needs will ensure continued growth. A growing practice is always worth more than a declining or static one. The value of the practice can be steadily improved during the f1nal 5 to 10 years by maintaining a positive attitude and following a client-oriented marketing plan that stresses quality service. As competition has increased within the profession, only those practices that continue to make improvements and meet client needs will continue to grow. As the practice's net income grows, the value of good will will grow at a 1:4 ratio, resulting in a marked increase in practice value.

Step 3: Keep the building and grounds in outstanding condition.

The approach to the real estate might be as simple as a fresh coat of paint inside and out, and a new building sign. The landscaping might also be updated to give the whole property a new look. If routine facility maintenance is performed regularly, the cost of final preparation of the building should be minimal. Major building renovations or additions should be avoided during the final five to seven years. This will allow the net income (excess earnings) to remain as high as possible.

If the practice does not own the real estate, then the lease should be negotiated so that the length remaining will be sufficient to provide stability to the new owner(s). The best type of lease would be multiple two- or three-year options for an 8- to 10-year period with stated rent increases.

Step 4: Keep all equipment in up-to-date condition to meet the growing needs of the practice.

Major equipment purchases (i.e., radiographic equipment, endoscopes, ultrasound machine) should be made five to seven years before sale when possible. Again, any major expenditure will have some effect on the net income. When replacement equipment is desired or required, used equipment may be purchased through human hospitals or used medical equipment web sites.

Step 5: Identify and develop potential qualified buyers.

Because of the increasing number of practices that will be sold and the increasing number of women veterinarians (who may be less interested in practice ownership), each owner must evaluate the best method of sale for their practice. Who are the potential buyers for veterinary practices? Several groups of buyers are available depending on practice type, size and location. The largest pool of buyers will come from experienced associates (inside or outside the practice) who have practice experience and have reduced their educational debt to a manageable level.

The second group of buyers is practice owners who want to expand or protect an existing practice. These buyers are highly discriminating because they have current knowledge of practice value and demographics in the local practice area. The third group of buyers are the large national corporations (LNCs). They usually have very specific requirements for gross, net, practice type and location. The LNCs are often willing to pay a reasonable price, but you must meet all their criteria (which eliminates most one or two person practices) and sometimes be willing to accept stock and unsecured debt as partial payment.

The fourth group of buyers is found outside the practice area by listing the practice through a national veterinary broker. This method of sale has become more popular as more practices have been put up for sale and as qualified buyers are more difficult to locate. The advantage is the sale details are handled by qualified people, but the downside is you must pay a fee for these services (8-10 percent).

The fifth group of buyers is recent or new graduates. This group, however, is probably the least likely to buy because of their growing debt load. The average debt load has grown to more than $60,000, with some students having debts more than $120,000. A few students graduate with little to no debt, and if they have family money they might be able to buy a practice within one to three years. Given the above choices of buyer groups, the experienced associate is the largest and best opportunity for a practice sale.

Experienced associates can reduce their educational debt to a manageable level within three to five years of graduation if they keep their standard of living at a reasonable level and are focused on practice ownership. The best way to sell smaller practices is to cultivate an internal sale to an associate you have worked with for several years. This approach will allow you to sell to someone you know and trust, and who has the ability to successfully manage the practice. Selling to someone who will not be successful only ensures the practice will be turned back in a devalued condition unless you are completely paid off at closing.

The real advantage of selling to an internal associate is you can control each step of the process while helping the associate secure his/her future. When is the right time to add an associate for potential sale? The best answer is before you burn out and when you are ready to sacrifice some personal income. When the stress level increases to the point of being uncomfortable and you are willing to trade off some income for free time, it is time to hire a full-time or part-time associate. In most practices the cost of the associates will be earned back within 12 to 18 months as the practice expands to accommodate the additional person and additional services. As the new associate increases the gross income, the value of the practice also increases. If the new associate works out to be a quality person who is compatible with the owner and has the drive to succeed in a practice of their own, then discussions can start on future ownership. Once the associate has been identified as interested, then some management duties can be delegated as a test of general management skills. If the results of the above are positive, then the value of the practice should be established and transitional planning started.

The transition time could be over a short period or extended to five years with 10 percent being acquired each year until 49 percent of the practice has been purchased. Once the sale has reached 5 1 percent, the original owner is now in a minority position and should be ready to step back or out of the practice. At this point, control of the practice is lost to the majority stock holder or controlling partner. The practice could also be sold all at once and the original owner(s) hired back for a specific transition period. This option has become more common within the last few years due to national banks becoming interested in loaning money to veterinarians for practice purchase. It is not uncommon for a national bank to loan the full value of the practice with no money down; veterinarians seem to enjoy a very low default rate.

Step 6: Develop parallel wealth to supplement the income from the sale of the practice.

As a general rule, it is risky to invest all your money in one type of investment (i.e. stocks, bonds, real estate, T-bills, CDs, etc.). Therefore, the practice owner should have parallel investment programs in addition to the growing value of the practice. Many practice owners own the practice real estate in addition to the value of the practice. This provides two avenues of potential growth: real estate value and practice value.

The family home is also an investment asset that should increase in value over time. In addition, most people should also be investing 10 to 15 percent of their income in a retirement plan such as a IRA, Roth IRA, IRA-SEP, or 401[K]. This would then allow investments to grow in real estate (home, practice facility, vacation home); practice value; and retirement plan (i.e. mutual funds).

Step 7: The final step to the succession plan is to maintain reasonable expectations of growth and return based on the risk of the investment and the length of time the investments are held.

The longer good investments are held, the greater the return. The use of real estate, mutual funds and a veterinary practice are all excellent investments. The key to wealth is having these investments build over time (30 to 40 years). Another important factor is to expect a reasonable return on investment of 8 to 12 percent annually during that period.

A final word about retirement. Do not expect your practice sale to totally replace your pre-sale practice income. As an example, if you sold your practice today for $1,500,000 (practice and real estate) you could expect to withdraw 6 percent per year (without using the principle) for your retirement. This would provide $90,000 of income per year. However, your practice pre-sale income could have been $150,000 per year. Therefore, you will need additional investments to fill the gap, and this is why you must have parallel investments. These parallel investments also allow you more flexibility as to when and how you retire.

Before you reach the final years of practice, start developing a succession plan to sell one of your most valuable assets. Start to develop an internal sale to a hand picked associate when the time is right. Then phase out of the practice at a controlled rate knowing you have developed and negotiated a fair value sale that will benefit both parties and assure continued service to your clients.

Dr. McCurnin is hospital director and professor at Louisiana State University's School of Veterinary Medicine.

References


1. Brown, J.P. and Silverman, J.D.: The Current and Future Market for Veterinarians and Veterinary Medical Services in the United States. JAVMA. 215: 161-183, 1999.
2. Cron, W.L., et al: Executive Summary of the Brakke Management and Behavior Study. JAVMA. 217: 332-338, 2000.
3. Wise, J.K.: Employment, Starting Salaries, and Educational Indebtedness of 1999 Graduates of US Veterinary Medical Colleges. JAVMA. 215:1783-1784,1999.

Table 1 -- Seven Steps of a Succession Plan

1. Develop a plan to exit at least seven to 10 years prior to retirement.
2. Aggressively grow your practice net income in the final five to eight years.
3. Maintain the real estate in outstanding condition (or secure a reasonable lease agreement).
4. Continuously update all equipment.
5. Identify and cultivate potential qualified buyers.
6. Develop parallel wealth.
7. Maintain reasonable expectations.



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